You won’t get too far into any discussion of construction work without the issue of surety bonds coming up. The concept of suretyship is both extremely common and widely misunderstood, and sometimes confused with traditional insurance. Let’s take a look at what exactly a surety bond is, who’s involved and what their roles are.
A bond of any type is a form of guarantee. In the case of a surety bond, the guarantee is that one party will perform a certain obligation. In the realm of construction that usually means the completion of a project.
There are three parties to a surety bond: The principal, typically a contractor, is the party undertaking the obligation. The surety company issues the bond, making the guarantee. And the obligee is the party who receives the benefit of the bond.
A contract surety bond provides financial assurance for building and construction projects by assuring the obligee not only that the contractor will perform the work by a certain date as outlined in the contract (performance bonding), but will also meet other obligations including:
- Promising that the bid has been entered into in good faith; that is, that the contractor intends to perform the work at the agreed cost (bid bonding).
- Paying certain subcontractors and suppliers in accordance with the agreement (payment bonding).
- Providing guarantees against defective workmanship and materials for a certain period (maintenance bonding).
- Guaranteeing to cities, counties or states that the principal will construct certain improvements such as sidewalks or drainage systems (subdivision bonding).
If that all sounds somewhat similar to insurance, it is. Surety bonds provide a safety net against financial loss, and they are regulated by state insurance commissioners. But there are key differences also: In traditional insurance, the risk is transferred to the insurance company, who will pay any qualifying losses. In surety bonding, that obligation falls to the principal.
And traditionally insured risk exposures are spread across many clients via the underwriting process. Surety underwriting is viewed as a form of credit issued to the principal.
Questions about surety bonding? Contact Consolidated Insurance.